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Inflation Declines As Fed Retracts Liquidity Pump!

The bad news is that commodities, and related commodity stocks from energy to miners, continue to be hammered due to the retraction of the liquidity pump by the Fed. The decline in liquidity, the resurging crisis in Europe and general concerns about the U.S. economy is leading to commodities being dumped across the spectrum as money moves back to the “safety” trade of the U.S. Dollar and government treasuries.

Today’s release of CPI showed the index to be virtually flat from last month but up 2.3% on a year over year basis. This is down from 2.7% and the slowest pace of gains (CPI is at a record high) since February, 2011. Unfortunately, while the Fed continues to talk about how sanguine inflation is – hourly earnings continue to grow at a rate less than inflation and savers, due to the Fed’s continued ZIRP, lose purchasing power every day.

However, the decline in commodity prices is also leading to the drop in inflationary pressures. The composite inflation index is an average of the PPI and CPI indexes. The decline in inflationary pressures is good news for corporations that are struggling to pass through recent increases in underlying commodity costs and it is a boon to individuals to garner a little relief from the gas pump, food prices and utility bills.

Unfortunately, while the decreases in inflationary pressures are a welcome thing for consumers and the Fed, the unwinding of the commodity trade as liquidity is sapped from the market place leads to lower stock market prices. The chart shows the rotation out of commodities and into the US Dollar. This is not a new event as the steady decline of the dollar has been pushing commodity prices higher particularly over the last decade. However, the continued policies being implemented to battle the current economic malaise will continue to pressure the dollar lower in the long term.

The same goes for interest rates. As the Fed has continually been pushing interest rates lower through interventions – the concurrent flight into the “safety” of the U.S. Treasury has assisted in pressuring rates lower and bond prices higher. The current debacle rippling through the Eurozone has boosted bond prices as of late, along with the US dollar, which has put further pressure on the commodity complex as the short U.S. dollar and long commodity futures “carry trade” has to be unwound.

Important to understand is that of the three legs to inflation – wages, the velocity of money and commodities, only commodities have been contributing to the inflation pressures through the economy. As stated above wages have remained stagnant and have failed to keep up with the rate of inflation. Banks remain cautious and continue holding onto huge levels of excess reserves which has led to a sharp decline in velocity. However, the current “flight to safety” will eventually subside and money will continue to chase commodities.

All asset classes eventually “revert to the mean” during their longer term trends. While it can be painful in the short term – the current reversion does not change our long term outlook for the continuation of the secular commodity bull market. The pressure on supply by the growing worldwide population remains a prevalent theme. That demand combined with the worldwide engagement of monetary stimulus will continue to create upward pressures on basic commodities and metals.

The inflationary pressures caused by rising commodity prices will continue to affect the average American while they are fighting the deflationary forces of real estate, wages, and overall purchasing power. This combination of effects hits consumers at home and in their wallets. It is really no wonder that sentiment polls remain mired at historically low levels three years after the end of the last recession.

About The Author

Lance Roberts – Host of Streettalk Live

After having been in the investing world for more than 25 years from private banking and investment management to private and venture capital; Lance has pretty much “been there and done that” at one point or another. His common sense approach has appealed to audiences for over a decade and continues to grow each and every week.

Lance is also the Chief Editor of the X-Report, a weekly subscriber based-newsletter that is distributed nationwide. The newsletter covers economic, political and market topics as they relate to the management portfolios. A daily financial blog, audio and video’s also keep members informed of the day’s events and how it impacts your money.

Lance’s investment strategies and knowledge have been featured on Fox 26, CNBC, Fox Business News and Fox News. He has been quoted by a litany of publications from the Wall Street Journal, Reuters, The Washington Post all the way to TheStreet.com as well as on several of the nation’s biggest financial blogs such as the Pragmatic Capitalist, Zero Hedge and Seeking Alpha.